THE NSW government has caved in to community and political pressure over coal seam gas, announcing a ban on all activity within two kilometres of residential areas and industry clusters, such as horse breeders and wine producers, across the state.

It has also announced that the Chief Scientist and Engineer, Mary O'Kane, will review all coal seam gas activity in NSW, including the effect on water catchments, and report on any risks by July.

The decision, endorsed by cabinet on Monday night, follows a surge in community anger that forced the energy company AGL to suspend plans to drill for coal seam gas beneath thousands of homes in south-western Sydney.

It comes just a fortnight after the federal Environment Minister, Tony Burke, set up coal seam gas as an election issue by attacking the state government's approval regime and threatening to use federal powers to intervene before the September 14 poll.

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The Premier, Barry O'Farrell, said suburbs, country towns and other urban areas would become ''no-go zones for CSG activities''.

''Families in residential areas should not have to worry about their quality of life being affected by the noise, visual impacts and other effects of coal seam gas mining," Mr O'Farrell said.

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The ban will apply to any coal seam gas proposal that has yet to be approved under the Environment Protection and Assessment Act or the Petroleum (Onshore) Act.

The decision, in effect, ends AGL's plans, which had been strongly opposed by the state MP for Campbelltown, Bryan Doyle, and the federal Liberal MP for Macarthur, Russell Matheson.

On Saturday, the federal Coalition's energy and resources spokesman, Ian Macfarlane, called on the state government to adopt the Queensland government's policy, which bans coal seam gas wells within two kilometres of towns with more than 1000 people.

The state Resources and Energy Minister, Chris Hartcher, responded by saying NSW already had the most stringent controls in the country.

As part of a package of reforms, the Environmental Protection Authority will be appointed as the lead regulator of environmental and health effects of coal seam gas activity in NSW, which will also need to hold an Environment Protection Licence.

The EPA will be in charge of compliance and enforcement and empowered to revoke licences if breaches are detected.

A new Office of Coal Seam Gas Regulation will be established.

Mr O'Farrell said the Chief Scientist's review would ''provide an evidence base to support better understanding of the CSG industry in NSW and identify any gaps in the management of risks arising from CSG activities''.

He said Ms O'Kane would also consider how to manage the impact of coal seam gas activity on residential properties in non-urban areas.

The NSW government has battled criticism from community, farming, environmental and industry groups since it announced its new rules for coal and coal seam gas activity last year. Industry groups said the new rules added a layer of expensive red tape.